Friday, July 16, 2010

BP, Obama and the Economics of Disaster

Dear Colleagues

This is an interesting essay ... some of which I agree with, and some I do not.

I agree with the idea that the bio-ecology of the BP Gulf has a huge value ... I consider the bio-value to be considerably higher than these experts, maybe because I spend a few years of my corporate career trying to build a business in the shrimp industry and the health of the coastal shrimp nursery grounds was absolutely critical to our company's profit performance. When the nursery grounds are shot ... the shrimp industry is over! But while shrimp was my business back then, I learned also about a lot of other marine resources ... and the damage being done is a lot more serious than anyone in the media seems to understand.

My guess is that the Earth Economics people are substantially underestimating the economic impact of damage to the bio-ecology ... not only because the questions about discounting, but simply because a lot of people choose a low money vocation because they get high value from the life-style. In the money economics calculation the value part of the quality of life equation is left out ... and the answer is massively wrong. If you think in terms of the answer being out by a factor of three ... that would probably be about right!

My calculation of the stock market value of BP at the time of the accident is about the same ... around $200 billion ... quite small compared to the socio-economic damage that the accident has caused. This is a total failure of corporate metrics and financial thinking to understand risk and to manage accordingly. In equity ... the whole of corporate BP should be put in escrow for the benefit of the people of the BP Gulf region.

As to what engineers can do ... I would argue that modern engineering is amazing. It has taken nearly three months for the engineers to come up with a "stop the flow" solution ... but it seems they may have succeeded. Well done. But the responsible executives that should have been managing risk and ensuring rapid response in the case of disaster clearly chose not to be adequately invested in risk mitigation solutions. In the short run the stockholders got profits ... in the longer run maybe the stockholders will find themselves losing their company!

Obama did right, in my view, by leaving BP responsible for engineering. Is there anyone in Washington and the Government bureaucracies that does engineering with any seriousness? The BP oil engineers ... and the other oil industry engineers are good ... though they do not think very much about the strategic financial and risk issues of their industry. Nor do they need to!

Society does not need Washington to take over the oil industry ... but it does need to make sure that legal obstacles to a correct "making whole" in the BP Gulf States are removed. Bottom line, expect that BP will invoke all sorts of legalities to remover themselves from responsibility. The law is on BP's side, essentially because most law is written with powerful special interests helping to do the writing!

Getting people to understand the cost of oil needs to happen ... but how. $4.50 a gallon at the pump in the USA has happened ... but low economic performance of the economy and the price is down to $3.00. What is the total cost of this product ... is it $1.00 a gallon or is it $15.00 a gallon. I don't think that gas should be taxed to make it expensive ... but I do think that the oil companies should be required to have a funded emergency pool so that disaster can be handled ... and to the extent that the pool is not funded, the government would tax punitively so that companies are encouraged to fund the pool. More on this another time.

I like this article ... I was a student of Roy Harrod a long time ago!

The unceasing dribble of bad news from the Gulf of Mexico has been running before our eyes for weeks now: dead plankton; hypoxic zones looming and worsening, the product of massive methane releases into the Gulf waters; withered marsh grass; dolphin carcasses. This ruin is plenty bad on its own terms. No one wants to live in a filthy post-industrial wasteland. You don't need to read metaphysical or transcendentalist philosophy to understand that clean, sparkling, azure seas rife with life are preferable to seawater lacquered with oil and peppered with Styrofoam and the rotting corpses of sea mammals. Everyone - almost everyone - knows this instinctively.

But a healthy ecology does a lot more than make the world aesthetically enchanting. When marsh grasses absorb the tidal swell from hurricanes, they prevent coastal communities from being destroyed. Marsh plants also absorb CO2 from the atmosphere, as does plankton. When those marsh grasses and plankton are damaged or destroyed, there will be more atmospheric CO2, and human beings will feel the effects of that CO2. Hurricane storm surges will hammer coastal cities previously protected by vegetative buffers much harder, and in a warming world, the largest storms will come far more frequently. This destruction will cost money to fix - money that would not have been spent if the oil had never been spilled in the first place.

The Mississippi Delta provides climate stability, food, furs, habitat, natural waste treatment and hurricane protection for its inhabitants. More than 90 percent of these benefits come from coastal wetlands, which can include both freshwater and saltwater marshes, tidal bays, estuaries and cypress swamps, and their value adds up to a ridiculously large sum.

Researchers from Earth Economics, a think tank focused on applying economic analysis to ecological issues, recently compiled a rough-and-ready estimate of that sum. They found that "The Mississippi River Delta ecosystems provide at least $12-47 billion in benefits to people every year. If this natural capital were treated as an economic asset, the delta's minimum asset value would be $330 billion to $1.3 trillion," assuming a discount rate of 3.5 percent a year.

The discount rate is slightly abstruse, but deserves a bit of an explanatory detour. The rate refers to how we value the present relative to the future. In that way, it is inversely related to compound interest. The National Oceanic and Atmospheric Association (NOAA) explains that, "Compounding measures how much present-day investments will be worth in the future, discounting measures how much future benefits are worth today."

So, how do we value the well-being of future generations as compared to those currently alive? And to what extent will future generations live in a more affluent society, better able to mitigate the effects of current ruinous activities?

3.5 percent is a relatively "low" discount rate, meaning it values the future relatively highly, although many argue - I think correctly - that discounting is fundamentally immoral, because a long-enough time frame will make even a very low discount rate able to reduce ecological holocaust to a mere accounting problem. In that sense, discount rates are unacceptable, a "polite expression for rapacity," as economist Roy Harrod put it. Some economists agree. Others do not. (Economists never agree about anything).

Still, ecological economics is certainly far better than most other economic paradigms, in which, as the authors continue, "Ecosystem service values are outside the market. They continue to produce benefits unless an action like the spill damages them." It is when the birds are silent that we miss their songs.

Ecological economics relies on discount rates to consider and valorize ecosystems and ecosystem services, accomplishing in theory what is already descriptively accurate about the real world: that the economy is "embedded" in society and the environment, and the limits imposed by human society and ecology necessarily impose themselves on those operating as actors in a market system. Pretending otherwise would be folly.

As Hungarian economist Karl Polanyi put it, "A self-adjusting market implied a stark Utopia. Such an institution could not exist for any length of time without annihilating the human and natural substance of society; it would have physically destroyed man and transformed his surroundings into a wilderness." Utopia for Polanyi was literal: a no-place, from the Greek, a place that could never exist.

The projected damages from the Deepwater Horizon explosion begin to suggest why Polanyi was correct. The team from Earth Economics notes that the pipeline leak is already harshly affecting the Mississippi Delta, although open water systems will also be polluted by the effusion, as well as the coasts of countries and states that ring the Gulf: Alabama, Mississippi, Louisiana, Texas, Mexico and Cuba. They add, "If we assume that the Mississippi River Delta will be the most affected region and that there will be a 10 to 50 percent reduction in the ecosystem services provided by the Delta, this amounts to a loss of $1.2 - $23.5 billion per year into the indefinite future until ecological recovery, or $34 - $670 billion in present value (at a 3.5 percent discount rate)."

Before the spill, BP was worth about $189 billion, or a fraction of the total measured value of the Mississippi Delta. Now, shareholders have dumped BP stock as projected damages mount, and the stock-market valuation of the company has dropped. It's at roughly $100 billion, while BP spokesmen bandy about rumors that their new "cap" has securely clamped down on the well. BP's assets, according to Fadel Gheit, an industry analyst, are "theoretically" worth $350 billion, while the projected clean-up costs run from $10 billion to $70 billion (although some high-end estimates put the costs at $560 billion). BP is getting walloped, but it is far from moribund. Soon enough, it will either (a) again be humming healthily along; (b) it will be temporarily taken over and managed by the federal government, which will restore it to fiscal health, socializing losses and the "costs" of trying to abate the damages to the ecosystem; or (c) it will be bought by another company in another massive illegal mega-merger.

None of those paths are acceptable. We know that other oil companies are operating their rigs in roughly the same manner as BP - they all had the same dim-witted emergency response plan. Even if we take the numbers on the ecosystem damages listed above as simply nebulous estimates, it's clear that catastrophes like the explosion aboard the Deepwater Horizon oil rig are literally intolerable. The paths above don't even target symptoms, and make further catastrophes inevitable.

Are there alternatives? Always. The best medium-term option would be a de-facto governmental takeover of America's energy infrastructure: massive gas taxes to bring gasoline's market-price to its real price of $15-or-so a gallon, which excludes the costs of CO2 emissions (with rebates for those without transportation alternatives), alongside government-built clean energy products funded using the proceeds from that tax. Energy production would be transformed into a socialized industry, like libraries or public hospitals. It might take a bit more than a nudge to bring Obama and a recalcitrant Congress around to that plan. People would need to flood the streets.

A more realistic option would be to dismantle BP, sell off its assets and use the money to repair the ecosystem to the extent possible - then set up a trust fund to be invested in green-energy products and distribute its profits to the injured parties. BP executives would see their pensions punitively garnished along with their houses and mutual funds, the misbegotten proceeds of BP's planet-killing added to the pot.

There is a precedent for this. Congress passed special legislation to target the bonuses of firms that received bailout money from the government, legislation which, recall, Obama proceeded to castrate nearly immediately. Congress has the power of taxation; it can tax what it wants and how it wishes to. The Supreme Court, under the impression that corporations are human beings, will certainly balk. Obama should pack it.

Perhaps the plan shouldn't stop at taxes. Perhaps we should be throwing oil executives into an Angola prison along with other thieves and murderers. As economist Dean Baker wonders aloud, "We still punish drunk drivers for their recklessness. This would be a good pattern to follow more generally. The executives of the major oil companies whose clean-up plans for the Gulf of Mexico involved procedures for rescuing walruses would find the matter far less humorous if it involved jail time. Is there any reason it should not?"

Baker's not an idiot. There's a reason we don't throw oil execs in jail. It's just a crappy reason: the defining measure of the American legal system is "special privileges for high-class criminals."

Does the electorate agree with such steps, steps which are not nearly as radical as $13-a-gallon gasoline taxes? Who knows? Pollsters don't compose surveys while looking at pictures of pelicans suffocating to death or oil workers burning to death, juxtaposed with snapshots of Obama in a harness with the reins in the hands of petroleum executives and financial firms. (Congress is worse, comprised mostly of marionettes who are almost incapable of independent action in the absence of a gale from below). Polls never ask, "Should we dismantle the oil companies and use the proceeds to transition to a green economy? Should oil company executives be thrown in prison? Is Obama, like every president, Republican or Democrat, in total thrall to large corporations, and if so, how should we deal with it?"

But polls do offer a few clues. They show that 62 percent of Americans think we're on the "wrong track." Forty-eight percent disapprove of Obama, while 45 percent approve of his presidency. The honeymoon is over, it's done. The only two things that voters dislike more than Obama's comportment in the White House are Congress - with 73 percent disapproval ratings, and 57 percent of respondents wanting a new representative - and BP. Right now, the American electorate probably likes Osama bin Laden and the National Socialist Party more than it likes BP. Two percent of the electorate has a "very positive" view of BP - they have probably been shorting its stock - and six percent has a "positive" view of BP; they probably were on Paxil when they were asked the question. Sixty-five percent want "more regulation" of the oil industry.

So what's the Obama administration doing? Well, the Mineral Management Service issued a permit recently to the Bandon Oil & Gas Corporation for a new offshore oil well some 50 miles off the coast of Louisiana. Bandon applied for the permit in April before the explosion, according to the San Francisco Chronicle. Obama is trying to impose a new moratorium on deepwater drilling. Who knows if our corrupt judiciary will toss it out. Increasingly large swathes of the population despise Obama, while their mirror image defends him religiously, perhaps amidst receding hope that Obama is retaining a miracle in reserve to repair his failing presidency and our failing country.

There are no miracles, just the slow grind of policymaking. If Obama wants to quiet his critics, perhaps he should do stuff instead of talk about doing stuff. Two-thirds of the population wants a transition to green energy. They don't like seeing the environment desecrated, seabirds floundering in hellish marshes and people incinerated on oil platforms.

Perhaps the oil companies should be disbanded and oil extraction categorically illegalized. Perhaps we can divert half of that $1 trillion defense budget to windmills, railroads, urban farms and an Apollo Project for green energy. That would be at least be a good start.

Does Obama get the depth of popular fury, or perceive the popular disappointment that will lead to a one-term presidency? Signs aren't good. Does Obama's bonhomie about the folks in Wisconsin needing jobs and $2 billion in "conditional" commitments to solar energy seem like enough to turn things around? It's like trying to stop a car going 60 miles an hour by using a toothpick as a roadblock. It's not an effort. It's a joke.

Writer Al Sandine comments on the "taming of the American crowd," the historical retreat from confrontation in the street. We better get untamed, and fast, because Obama isn't going to turn things around for us. We will have to turn him around, and give him a push, too. And we'd better do so before it's too late.

About Me

Read engineering and economics at Cambridge ... qualified as a Chartered Accountant ... professional and corporate management working on management information and metrics of performance. International assignments as CFO and then as consultant to World Bank and UN agencies in connection with development projects and emergency situations. Work on planning at the national, area, sector and community level. Appalled at the current state of financial reporting in the corporate world and the metrics that drive major decisions in both the corporate and political sphere! The development of Community Analytics (CA) is a response to the need for better metrics than merely money accounting ... the concept of value should be treated with equal rigor and sophistication!